Motivating ESG activities through contracts and taxes

36 Pages Posted: 27 Jan 2022 Last revised: 10 Jul 2022

See all articles by Jonathan Bonham

Jonathan Bonham

The University of Chicago Booth School of Business

Amoray Riggs-Cragun

University of Chicago Booth School of Business

Date Written: January 24, 2022

Abstract

Using a principal-agent model in which shareholders care about financial as well as environmental and social (ESG) outcomes, we show how contracts and regulation shape a firm's financial and ESG activities. An ESG measure is included in the contract if the ESG outcome is intrinsically valued by shareholders, if it is informative about profits or if it is subject to regulation. Regulation affects the optimal contract, and in turn, the equilibrium distribution over financial and ESG outcomes. We show that when financial and ESG outcomes have non-zero correlation, regulating one outcome induces changes in the other; we show that quadratic tax schemes can be used to motivate interior ESG targets such as diversity (e.g., 50\% female); and we show that tax schemes that interact ESG and financial outcomes make those outcomes more correlated in equilibrium (e.g., through ``green innovation''). These schemes are more effective when measurement is more reliable. When ESG measures are unreliable, ESG subsidies exacerbate greenwashing, and subsidizing (taxing) the financial performance of firms with ESG-aligned (-misaligned) technologies is more effective for improving ESG outcomes.

Keywords: ESG, CSR, shareholder welfare, carbon taxes, regulation, optimal contracting, executive compensation.

JEL Classification: D86, M41, Q56, Q58

Suggested Citation

Bonham, Jonathan and Riggs-Cragun, Amoray, Motivating ESG activities through contracts and taxes (January 24, 2022). Chicago Booth Research Paper No. 22-05, Available at SSRN: https://ssrn.com/abstract=4016659 or http://dx.doi.org/10.2139/ssrn.4016659

Jonathan Bonham

The University of Chicago Booth School of Business ( email )

1101 East 58th Street
Chicago, IL 60637-1561
United States
7738344748 (Phone)

HOME PAGE: http://https://www.chicagobooth.edu/faculty/directory/b/jonathan-bonham

Amoray Riggs-Cragun (Contact Author)

University of Chicago Booth School of Business ( email )

5807 S Woodlawn Ave
Chicago, IL 60637
United States

HOME PAGE: http://www.riggscragun.com/

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